A thaw in the Russian permafrost
Is Russia a kleptocracy overseen by President Putin and his billionaire cronies, where foreign investors should fear to tread? Or is it an unloved market of ultra-cheap shares offering a potential bonanza for the bold? Perhaps both are true.
Retail investors over the past five years have suffered from a permafrost. Jupiter Emerging European Opportunities, run by the redoubtable Elena Shaftan, is down 14 per cent over five years, down 9.2 per cent over three years and over one year it is up a paltry 3.6 per cent. Its principal competitor, Neptune Russia and Greater Russia, is better over five years (managing to at least stay in positive territory, if only just) but has lost money over the past year.
These figures tell you that Russia is either a busted flush, or that there are bargains everywhere. Perhaps unsurprisingly Shaftan suggests it’s the latter.
“It’s the only emerging market which has seen investor outflows but where earnings growth has actually kept pace with other emerging markets. Russia has now derated and is on a valuation of 60 per cent that of other emerging markets.”
The fund has ‘emerging Europe’ in the title, but three-quarters of its £280m in assets are in Russia, while 21 per cent are in Turkey. The emerging Europe of Poland, Hungary, Czech Republic, etc, are virtually submerged. Poland makes up just 1.4 per cent of the fund, followed by Croatia with 0.6 per cent.
Unlike Russia, Shaftan reckons that many Eastern European countries really are a busted flush, a geared play on problems in Western Europe, desperately uncompetitive and wrecked by earnings downgrades.
But Russia is a different story. “Compared to the other emerging markets, its GDP growth is a bit slower, at around 3.5 per cent, but it has a solid national balance sheet, a current account surplus and the rouble is appreciating. The market also appears to be decoupling from the oil price,” she says.
What one thinks about oil is crucial to how, when and where one invests in Russia. Shaftan is keen to play down the importance of Russia as a play on oil, but she acknowledges the huge influence of energy stocks on the market.
The Moscow market has 50 per cent of its total capitalisation in energy stocks, led by Gazprom. Shaftan has about 27 per cent of the fund in energy. “We are particularly underweight in gas stocks,” she says, although she has 4 per cent of the fund in Gazprom, compared with its 10 per cent market weighting.
“Gazprom is now ridiculously cheap. It’s on 2.5 times earnings and has a 4 per cent yield. But for too long it has treated its investors with indifference at best.”
She prefers Lukoil, at 8.6 per cent of the fund her largest single holding. “They were in London a fortnight ago, they are a privately-owned company and they are genuinely interested in investor perceptions and what they can do for investors. Gazprom is still a large, inefficient state-run company that has to put make up on when it sees investors. But I suppose they are at least bothering to put make up on.”
Shaftan doesn’t avoid state-controlled entities altogether, although she’s keener on smaller and mid-size companies outside the main index. She is, though, a big fan of Sberbank, “a fundamentally well-managed company, which has been my favourite company of the last 10 years in Russia. It was ridiculously cheap. They have a 50 per cent share of the Russian banking market.”
But when anybody talks about Russian corporate management, it’s impossible not to mention Sergei Magnitsky. He was the accountant and auditor for a US investment advisory firm, Hermitage Capital, who made allegations about large-scale, systematic theft carried out by Russian government officials, including the creation of fraudulent shell companies, authenticated by corrupt judges. His life ended in prison a year after making the allegations public.
Shaftan doesn’t argue with the facts about the Magnitsky case. She just says there are lessons to be learnt. And the number one lesson is that foreign investors should not pick a fight with the Russian government. “It’s better just to sell your shares and go somewhere else, rather than being on the side of right,” she sighs.
But she is hoping that the latest anti-corruption drive might yield more results than in the past. “We started seeing heads rolling in November last year, such as the head of their ministry of defence. We are hoping it is concerted action to clean up the system. We are also seeing some important financial reforms, such as the creation of a central depositary and a western-style settlements system, which should allow American investors in.”
Pension reforms should see more domestic cash flow into equities. Currently the equity allocation of local pension funds is just 3 per cent, while in Poland it is closer to 30 per cent.
Fiscal reforms will prevent the government squandering the country’s rich resources. Any revenue above a $91 oil price goes into a reserve fund for national welfare, although its credibility is a long way from being tested.
But what excites Shaftan most is something everybody can celebrate. Russia is finally getting a grip on its appalling health and medical issues. They are drinking less, and drink-driving less too. “The decline in the population has finally stopped. It’s a very big and important shift. The demographics are no longer against the Russia story.”
But there are plenty of issues which are against the Russia story. Syria. Cyprus. Ultra-corrupt billionaires and politicians. Even shale gas in the US, which massively devalues Russia’s reserves. Russia may offer value, but there are good reasons why it should trade at a large discount for some time to come.
Patrick Collinson is the Guardian’s personal finance editor